Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Wednesday, 29 April 2015

In the UK, deposit insurance is funded by taxpayers, which equals a subsidy of banks. As the UK’s Vickers commission on banking rightly put it, “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.” So to that extent, deposit insurance UK style is a nonsense.

In the US, small banks are insured by the Federal Deposit Insurance Corporation, and the FDIC pays for itself: better than the UK system. However, even FDIC type insurance has logical flaws as follows.

Deposit insurance wipes out the profit from accepting risk.

The return demanded by savers and investors splits into two elements. First there is the reward required for abstaining from consumption. (Incidentally the market price for that “abstinence” is currently around zero: e.g. the return on near zero risk investments (e.g. German government debt) is around zero. But normally a positive reward is offered.)

Second there is the reward required for accepting risk. However if the chance of losing everything in any one year is X%, then the reward for undertaking that risk will be X% and the appropriate insurance premium will also be X% of the capital sum insured: the insurance premium wipes out the reward offered for accepting the risk! Or to be more accurate, the insurance premium MORE THAN wipes out the reward because insurers have administration costs and (in the case of private insurers) are in business to make a profit. So FDIC type insurance is of little benefit to depositors, plus it does not result in banks being funded more cheaply. To that extent it’s a farce!

And it is not the job of the state to engage in farcical activities. But that’s not to say PRIVATE INDIVIDUALS should be barred from engaging in farcical types of insurance. E.g. if someone wants to insure their pet cat for a million dollars, there’s no reason to stop them.

Likewise, if people want to arrange PRIVATE insurance for their bank deposits, there is no reason to stop them.

The vast sums needed to fully insure bank deposits.

One of the alleged merits of FDIC type insurance is that it encourages people with money to spare to have their money put it into the real economy rather than simply lodge it with the central bank. That option of “lodging with the central bank” is available in the UK in the form of placing deposits with the state run savings bank, “National Savings and Investments”, and that facility is doubtless available in some other countries. Those deposits are not much different to keeping spare cash under the mattress.

Now as implied above, there are two types of insured bank funders: first, shareholders and bond-holders who self-insure, and second, depositors who have FDIC type insurance.

But the FDIC option involves a destabilising flow of funds when a large bank fails. That is, the insurer has to keep large funds in some sort of liquid asset which is then sold when a large bank fails. Unfortunately, the sums needed when a large bank, and more importantly, a SERIES of large banks fail, are so huge, that the above destabilisation is arguably as bad as letting banks fold. That is, whatever liquid asset is involved, its value would crash when a large proportion of it was sold so as to fund the rescue of millions or billions of dollars worth of deposits which had gone west.

An alternative is for the insurer to hold VAST amounts of base money: a sum approximately equal to the total of deposits insured. But wait a minute: that involves having large sums doing nothing – exactly what deposit insurance is supposed to avoid! The whole thing is still a farce!

Cheating the insurer.
Another problem with FDIC type insurance is the temptation to cheat the insurer. For example, if your car is insured against theft, that’s an inducement to take less care about locking it when leaving it unattended. 10% of car and house insurance claims in the UK include an element of fraud. Likewise, with FDIC type insurance, the bank will take bigger risks than where no insurance is offered.

Sometimes that inherent defect in insurance is a price worth paying. That is, insurance really comes into its own where the objective is to avoid total ruin, as distinct from reimbursing you in respect of a loss that you can easily carry without being ruined. Indeed, the fact that many insurance policies involve the insured party paying a so called “excess” (e.g. paying the first hundred pounds or two in the case of car or house insurance claim) is a recognition that insuring against SMALL LOSSES is a waste of time.

But if FDIC type insurance is abandoned, the result would be that the proportion of bank funding that comes from shareholders or quasi shareholders like bond-holders would rise. Indeed, if deposit insurance is abandoned than arguably ALL BANK FUNDERS ipso facto become shareholders: that’s shareholders as in “someone who at worst stands to lose everything”.

But if banks are funded largely or only by equity, they are highly unlikely to be “ruined” i.e. go insolvent. Ergo the above “avoid ruin” merit in FDIC type insurance is nothing to shout about.

Bank failure probably means too much has been loaned.

A final nail for the “FDIC coffin” is as follows. The mere fact of bank failure (and more important, a SERIES of bank failures) is an indication that too much lending has taken place, and hence that banks should shrink their operations. And that’s exactly what happens with a bank is funded just by equity: shareholders take a haircut, and there’ll be a reluctance to put money into banks for a while.

In contrast, given FDIC type insurance, depositors lose nothing. Thus after one bank has been closed down (normal FDIC procedure), depositors will then put all their money into another bank, safe in the knowledge that (again) they cannot lose, despite the new bank taking excessive risks or lending too much (assuming the bank industry AS A WHOLE has been lending too much).

In short, FDIC type insurance prevents a normal market mechanism working properly: the scaling down of an industry when the industry has grown too large.

Conclusion.
There is much to be said for abandoning deposit insurance. Instead, those who want total safety could lodge their money with the state or central bank. And as to those who want their money loaned on or invested, they’d accept the risks involved just as they do with stock exchange investments.

Indeed, if you lend to a corporation by buying its bonds, you accept the risk involved. But if you place money in a bank which lends to the same corporation, and it all goes wrong, you’re protected by deposit insurance. The logic eludes me.

If FDIC type insurance WERE abandoned, there would of course be an initial deflationary effect: people would withdraw money from the real economy and lodge it with the central bank or similar. But that deflationary or “demand reducing” effect is easily countered by standard stimulatory measures.

Sunday, 26 April 2015

Above chart is from here.
I’m not sure that it’s totally accurate because I’ve seen other sets of figures which indicate that house price increases in some other countries are a bit higher than in the UK. But certainly UK house prices are amongst the highest in the world. (The Economist interactive house price index is a useful source of information.)

And the explanation for high UK house prices is simple: reluctance on the part of the authorities to release land for house building, i.e. to allow building to take place on land currently used for agriculture - or which is OSTENSIBLY used for agriculture. I say “ostensibly” because a significant proportion of so called agricultural land is nothing of the sort: thanks to Europe’s crazy agricultural policies, such land is actually not being used at all.

The extent to which that reluctance to permit building contributes to the rise in house prices is easly calculated by looking at the difference between the price of agricultural land and land with building or planning permission.

The price of agricultural land HAS RISEN substantially in the UK in recent decades. But that is completely DWARFED by the price of land with planning permission. According to this article, the price of farmland rose from £54 an acre 60 years go to £6,900 today.

In contrast, the average price of land with planning permission in the UK rose to £4million per hectare in 2008 (roughly £2million per acre). That’s according to this source.
That £4million per hectare DID FALL BACK to £2,400,000 in 2010. Nevertheless, hopefully I have established that the rise in the price of farmland over the decades is near irrelevant. The important point is the PREMIUM that has to be paid to obtain land with permission to build.

As an Institute of Directors publication put it in bold type on its first page, “At the root of high prices and small new houses is the high price of land with planning permission for residential construction.” (Publication title: “Land Supply and the Housing Market”.)

Or as this Policy Exchange work on the subject concluded, “Our planning system set out to predict and provide the housing we need, but as the flaws in the socialist model of provision became obvious it evolved to become a system that constrained development in order to protect the countryside. This has significant costs – we now live in some of the oldest, pokiest and most expensive housing in the developed world.”

As to the actual extent to which artificial restrictions on permission to build contribute to the cost of the average house, this work estimates that those restrictions added £40,000 to the cost when the average house price was £120,000. I.e. a substantial relaxation on those restrictions would cut the cost of the average house by approaching one third.

Let’s provide immigrants with nowhere to live!

One of the barmy elements in all this is the fact that the average Brit adheres to two mutually exclusive ideas on this subject. First the average Brit favours mass immigration (probably because it’s PC to favor immigration, and/or because some nastly little leftie will scream “racist” at you if you aren’t too keen on immigration).

Second, Brits almost invariably oppose housing development in their own neighbourhood. All of which raises the question: where does the average Brit suppose that immigrants are going to live? The Outer Hebrides perhaps?

As the above Policy Exchange work puts it in reference to the question as to why the UK has such severe restrictions on allowing houses to be erected on greenfield sites: “Why has this come about? One answer is that the political alliance to protect the countryside is very strong. The Campaign to Protect Rural England is one of the most successful pressure groups in Britain with about 59,000 members.”

Incidentally, I’m not suggesting immigration is necessarily the biggest factor on the DEMAND side of the equation: another important factor is the decline in the number of people per household in the UK over the decades. But immigration is certainly a SIGNIFICANT contributor.
To summarise, Brits need to get something into their thick skulls. If they want mass immigration and fewer people per household, and a garden and assuming Brits don’t want to live in the smallest and most expensive houses in Europe, then more countryside will have to be allocated to house building.

Does the bank system contribute to house price increases?

And finally, a currently popular explanation for recent house price increases is that private banks can create money out of thin air and lend it, for example to mortgagors. Unfortunately there is a very obvious flaw in that argment, namely that we’ve had that bank system for almost two hundred years. Thus there is no reason it should have contributed to house price increases just in RECENT decades. (That system is sometimes called “fractional reserve”).

It may of course be that lending standards HAVE BEEN relaxed in recent decades, and no doubt that would contribute to a rise in house prices. But then WHATEVER bank system you have, and given a relaxation of standards, the effect would probably be the same.

Wednesday, 22 April 2015

There has been an argument in recent years between those who adhere to the so called “loanable funds” theory and those who adhere to the endogenous money theory.

The first lot claim that banks intermediate between borrowers and lenders and that one person cannot borrow till another has saved up and loaned money to a bank. In contrast, the endogenous money lot claim that saving is not needed because a bank can simply create money out of then air and lend it out. That is, commercial banks when they see creditworthy potential borrowers can simply open accounts for them and credit them with money (perhaps after having taken collateral off the borrowers, or perhaps not).

Well now, if an economy is at capacity (aka full employment), then the extra aggregate demand (AD) that stems from creating and spending that new money is just not permissible: else excess inflation ensues, unless savings are increased (which has a deflationary effect). If savings DON’T increase and if market forces don’t raise interst rates and choke off additional borrowing, then the central bank will raise interest rates so as to bring AD back to its “acceptable inflation” level (NAIRU, if you like acronyms).

On the other hand, if the economy is NOT AT capacity, then there is no need for new lending to be constrained by how much is saved.

So the loanable funds lot are right where the economy is at capacity, and the endogenous money lot are right where the economy is NOT AT capacity. So the new law (untill such time as I decide it’s nonsense and withdraw it…:-)) runs as follows.

“Where, or to the extent that an economy is at capacity, lending is constrained by saving. But where or to the extent that an economy is NOT AT capacity, lending is NOT constrained by saving.”

(Incidentally, the latter law occurred to me while taking part in a discussion on this blog about the loanable funds v endogenous money argument. That’s the beauty of blogging: it forces you to THINK!)

__________

P.S. (24th April 2015). Re my above suspicion that the above "law" is not original, it actually looks like Keynes said something similar: i.e. that when it comes to the effect of additional loans on interest rates, there is a difference between where the economy is at capacity and where it is not.

Monday, 20 April 2015

I like this United Press International article entitled “The US is not a democracy but an oligarchy, study concludes.” The study has apparently been done by folk at Princeton and Northwestern Universities.

The summary of the article reads "The central point that emerges from our research is that economic elites and organized groups representing business interests have substantial independent impacts on US government policy, while mass-based interest groups and average citizens have little or no independent influence.”

Er yes. I suspect most taxi drivers are aware that Jamie Dimon and Lloyd Bankfiend make regular trips to the White House with a view to licking the president’s arse - sorry I meant with a view to discussing paying for election expenses. Any connection between those payments and subsequent bank friendly legislation, and a continuation of “socialism for the rich” are of course entirely coincidental.
I wouldn’t describe the above study as revelatory.

Sunday, 19 April 2015

Summers’s original SS idea, was that we’re doomed because there’s been a significant rise in the desire to save and there’s nothing we can do about it because interest rate cuts are the only way of raising demand, and interest rates are currently at or near zero. (More on the latter point here.)

Summers may not have heard of Keynes, but Keynes pointed to the same problem about seventy years ago. Keynes called that the “paradox of thrift”. That’s the fact that saving money reduces demand and raises unemployment. And as Keynes rightly pointed out, the solution is essentially to print more money and spend it till “savings desires” are met (to use MMT parlance).

However, the Financial Times has done us the great service of adding to the nonsense. In this op-ed article the FT claims that the solution to SS is “Investment and productivity have meanwhile disappointed. These factors strengthen the case for the government borrowing to invest. The purpose would be to raise the sustainable growth rate.”

Well there’s certainly a strong case for Keynes’s “print and spend” solution, but why concentrate on “investment”?

Of course “investment” is an EXTREMELY SEXY word. If you run around advocating more investment and you’ll have a HUGE following, even if the investment you propose is completely pointless. Investment involves sacrificing current consumption, and ever since the world began, human beings have adhered to a variety of religions all of which have one thing in common: sacrifices must be made to placate the Gods. God knows (pardon the pun) why that desire to lash oneself with chains like Shiite Muslims on their way to Karbala is so ingrained in the human brain, but it just is.

Anyway, returning to economics, whence the assumption made by the FT, namely that because stimulus is needed, that therefor the stimulus must take the form of more investment? There is only one valid reason for making an investment, and that’s the fact that the investment seems to pay for itself: i.e. it’s a cheaper way of doing something than a more labour intensive method.

And there is very little reason to think that the number of potential investments which meet the latter criterion will hugely expand just because stimulus is needed.

As for the fact that productivity improvements have recently been poor, that poor performance is NOT NECESSARILY down to lack of investment: it could be that the pace of technological change is slowing (or to be more accurate, the pace at which technological change can boost productivity via sundry investments may have slowed).

So how do we determine the truth or otherwise of the latter point? Well it ‘s easy: just carry on making investments where they pay for themselves, and not where they don’t. To repeat, the fact that stimulus is needed to counter secular stagnation has no bearing on the latter “pay for themselves” point.

Saturday, 18 April 2015

I’m a fan of Adair Turner (former head of the UK’s Financial Services Authority). But he rather goes off the rails in this article, where he (and co-author Susan Lund) worry about rising levels of debt.

As Turner and Lund point out, just under half the increase in debt worldwide in the last five years or so is attributable to increased NATIONAL debts. The first flaw in that argument is that (as pointed out by Martin Wolf in the Financial Times recently) national debt at low rates of interest is essentially the same thing as money (base money to be exact).

As Wolf put it, “Central-bank money can also be thought of as non-interest-bearing, irredeemable government debt. But 10-year Japanese Government Bonds yield less than 0.5 per cent. So the difference between the two forms of government “debt” is tiny…”. Indeed interest rates on government debt is currently at an all time low (Greece and one or two other countries apart).

Another relevant factor when it comes to the similarity between government debt and money is the TERM of the debt: i.e. the time till maturity. That is, government debt is simply a promise by government to pay the debt holder $X in Y days or Z months time. And if there’s say just one week till maturity, then what’s the difference between $X on the one hand, and on the other, a promise by government to pay you $X in a week’s time? Not much difference!

Indeed, short term government debt is used in lieu of cash in the world’s financial centres.

So when T&L say “Much of this debt accumulation was driven by efforts to support economic growth in the face of deflationary headwinds after the 2008 crisis”, that can be more accurately re-phrased as “It has proved necessary to supply the private sector with a larger money supply in order to keep the private sector spending at a rate that brings full employment”.

And frankly I don’t see much wrong with doing that. If people want to carry around more dollar bills in their wallets (or keep wads of dollar bills under their mattresses), what’s the problem? Let them have the dollar bills they want!

T&L then say “But excessive reliance on debt creates the risk of financial crises, which undermine growth.” Really? Japan has had HUGE levels of government debt for a long time and far as I know, no “financial crises” has resulted from that.

I’m not suggesting that supplying the private sector with a larger than normal stock of money (in the form of government debt or base money) is TOTALLY without risks: it’s always possible the private sector goes wild and tries to spend it all at once which would cause rampant inflation, unless government managed to counter that with some sort of deflationary measures. But it’s better aim for full employment and accept that risk, than have excess unemployment isn't it?

Private debt.

As distinct from government debt, there is PRIVATE debt, and that, as T&L rightly point out has risen substantially. On the other hand, and to repeat, interest rates are at record lows. In fact they’ve been declining steadily for thirty years. Thus debtors can now take on more debt than they used to. So to that extent, there is nothing to worry about.

____________

P.S. (6.30, same day): I should perhaps have answered the question as to what to do if and when interest rates rise on national debts. Answer: don't roll them over. I.e. just print money and pay back creditors. And if that's too inflationary, then raise taxes, i.e. grab that money back from the private sector. Easy.

Friday, 17 April 2015

An idea which has been around for a VERY LONG TIME, is that it is in theory possible to abolish unemployment by simply having government pay the unemployed to do SOMETHING instead of nothing (well, “nothing” plus a bit of job searching).

Those refusing this sort of work, could be regarded as having turned down work, and could thus perhaps no longer be classified as unemployed. Hey Presto: unemployment vanishes. Well in theory it does!

That sort of idea was implemented big time in the 1930s, for example there was the “Work Project Administration” in the US which built vast numbers of roads, bridges, buildings, etc. And 2,600 years ago Pericles in Ancient Athens did the same: put the unemployed onto public construction projects (according to “Unemployment in History” by John Garraty, Ch.2, p.13)

I’ll call this idea “Job Guarantee” (JG) because that’s currently a popular label. And one important question to sort out is whether JG should take the form of SPECAILLY SET UP PROJECTS, as was the case with the WPA in the 1930s, or whether such work should be merged with the EXISTING public sector: i.e. should JG employees be allocated to EXISTING public sector employers (schools, the armed services, etc)? I’ll consider whether JG employees should be allocated to existing PRIVATE SECTOR employers below.

In fact there’s a simple flaw with specially set up projects which is that (almost by definition) they involve a odd ratio of different inputs – permanent skilled labour, unskilled labour, materials, and capital equipment.

That is, a typical JG “specially set up” project consists of a relatively large number of recently unemployed people (who tend to be unskilled) working alongside a smaller than usual quantity of skilled labour, capital equipment, etc. And that means inefficiency.

Of course a JG specially set up project CAN INVOLVE a relatively large amount skilled labour, capital equipment etc as was the case with many 1930s WPA construction projects, but in that case, such schemes come to the same thing as a normal or regular employer! In short, specially set up JG schemes are in check mate: either they involve an odd ratio of inputs, or they don’t in which case they amount to a normal employer.

In the UK there is a JG scheme up and running at the moment called the “Work Programme” which allocates subsidised employees to existing employers public and private. So in that that scheme allocates JG people to existing employers, the Work Programme makes sense (not that I’m suggesting the Work Programme is anywhere near perfect.).

Incidentally, some readers may want to raise the objection at this point that public sector employers like schools and hospitals can find work for hoards of unskilled youths is plain unrealistic. That’s true, but private sector JG solves that problem. Speaking of which….

Private sector JG.

A second important question that needs answering in relation to JG is whether JG people should be allocated to PRIVATE SECTOR employers.

A plausible reason for limiting JG to the PUBLIC SECTOR is that no extra DEMAND is needed in order for the output to be produced and consumed: that is, the output is simply given away. Ergo (allegedly) there’s no inflationary threat.

However, an obvious flaw in that idea is that we’ve seen a HUGE INCREASE in the proportion of GDP allocated to the public sector (aka the “give away” sector) over the last century or two, yet there’s been no corresponding decline in unemployment. So what’s the explanation? Well we need to look in a little detail at what causes inflation (demand pull inflation to be exact).

The cause of inflation.

Inflation rises when employers cannot find enough of the ultimate source of all supply, i.e. labour (skilled labour in particular). And when people get regular jobs they normally cease looking for alternative jobs: i.e. they cease being a source of skilled labour for labour shortage areas (skilled ones in particular).

Thus if employment is at the maximum feasible level (sometimes called NAIRU) and government creates new public sector jobs, that will be inflationary NOT JUST because of the extra spending, BUT ALSO because skilled labour shortages are exacerbated.

So if JG labour is to be allocated to private sector employers, a way must be found to increase demand which DOES NOT increase demand for skilled labour. And JG ought to do that since JG labour is supplied to employers at a subsidised rate (or for free), which in turn means employers will raise the number of unskilled employees they take on relative to the number of skilled employees.

Plus (to repeat) it’s important not to reduce the efforts by JG people to find regular or unsubsidised work when they get JG work. And that can probably be achieved by having pay for JG work about the same as the pay obtainable on unemployment benefit. Indeed the UK’s Work Programme pretty much fulfils that requirement: pay is not spectacular.

Another point in favour of private sector JG is that the “post JG” employment records of those who have done private sector JG is much better than those who do JG jobs in the public sector or charity sector, according to some Swiss research. See here and here.

And a further advantage of private sector JG is that the private sector is better at employing the relatively unskilled than the public sector.

Is JG worth it?

That is, does the output obtained from JG employees exceed the administration costs of JG schemes? The administration costs of the Work Programme have been so high that it’s questionable whether JG schemes are worthwhile. Or maybe it’s the Work Programme as such that is at fault.

One possibility which might have a better cost/benefit ratio is to make JG purely voluntary (as was the case with one Swiss JG scheme): that is not incorporate any sort of Workfare element. By “Workfare element” I mean “do this job else your benefit gets cut”.

Thursday, 16 April 2015

"Finally, a principal motivation that proponents offer for changing the monetary policy target is to deal more effectively with the zero lower bound on interest rates. But economically, it would be preferable to have more proactive fiscal policies and a more balanced monetary-fiscal mix when interest rates are close to zero. Greater reliance on fiscal policy would probably give better results, and would certainly be easier to explain, than changing the target for monetary policy. I think though that the probability of getting Congress to accept larger automatic stabilizers and the probability of their endorsing an alternative intermediate target for monetary policy are equally low."

Translated into plain English, that's "Economic growth in the US would be much better if it weren't for that monkey house down the road known as "Congress"".

Further translations of overly diplomatic language into brutally realistic English will appear here from time to time.

Wednesday, 15 April 2015

Martin Wolf is the Financial Times chief economics commentator and he is my own favourite economics commentator (an accolade which is of course much more important than the above FT one). But he goes off the rails in today’s FT.

His basic claim is that, “Output . . . is financially unsustainable if generating enough demand to absorb the output of the economy requires too much borrowing or real rates of interest that are far below zero.” Wolf actually attributes that idea to the latest IMF World Economic Outlook. But I’ve been through that IMF document and while there is material that hints at the latter “unsustainable” idea, I couldn’t find anything very specific. But never mind.

The important point is that the above “unsustainable” argument is plain wrong and the flaw in it is simple and is thus. Demand CAN BE generated by cutting interest rates, but it’s not the only way. One of the alternatives is simply to have the state create and spend new money into the economy (and/or cut taxes). Indeed, that’s exactly what we’ve done over the last three years or so. That is, we’ve implemented fiscal stimulus (government borrows money, spends it and issues bonds to its creditors), and followed that by QE (the state prints money and buys back those bonds). That nets to “the state prints money and spends it, and/or cuts taxes”.

Indeed, the latter method of implementing stimulus is exactly what the leading advocate of Modern Monetary Theory, Warren Mosler, proposes in his “Mosler’s law”. That law reads “There is no financial crisis so deep that a sufficiently large increase in public spending cannot deal with it.”

The above Wolf idea, namely that there is nothing government can do to increase demand when interest rates are zero is exactly the fallacious point that Lawrence Summers made in his original “secular stagnation” speech to an IMF audience in 2013.

As Summers put it, “But imagine a situation where natural and equilibrium interest rates have fallen significantly below zero. Then, conventional macroeconomic thinking leaves us in a very serious problem…”. Er no. There is NO PROBLEM there whatever. As to “serious problems”, forget it.

Actually it’s not entirely clear what Summers is trying to say, but in as far as his speech is decipherable, I go along with the summary of it set out by Gavyn Davies in the Financial Times.

As Davies puts it, “In a largely unsuccessful effort to close the gap, the central banks have created asset price bubbles (technology stocks in the late 1990s, housing in the mid 2000s and possibly credit today), since this has been the only means available to boost demand.”

I.e. Davies seems to be saying that central banks have cut interest rates to near zero (which has created “asset price bubbles”). Plus Davies confirms that what Summers seems to suggest is that interest rate cuts are the “only means available to boost demand”, to quote Davies. That is nonsense.

The reality (as MMTers keep pointing out) is that a government which issues its own currency can choose any combination of interest rates and stimulus it wants. For example with a view to escaping zero rates (which according to the IMF, Martin Wolf and Summers is some sort of horrendous problem), such a country just needs to proceed as follows.

First print and spend large dollops of money into the economy (and/or cut taxes). That will raise the private sector’s stock of money (base money to be exact). And there has to be some point at which (as MMTers keep pointing out) the private sector has so much money that interest rates have to be raised in order to prevent aggregate spending rising too far and sparking off excess inflation. Moreover, the latter strategy can in principle be used to raise BOTH stimulus AND interest rates as far as you like. And what’s nice about that solution is that it disposes of the asset price bubbles (if you believe they’re a problem).

It should of course be said that while the latter strategy is a very simple solution IN PRINCIPLE to the problem that Summers, Wolf etc seem to think is insoluble, that does not mean that actually implementing the strategy would be all plain sailing. But then steering a course between excess inflation and excess unemployment is NEVER EASY!!!

Another possible criticism of the above “print money” strategy is that it is arguably a classic example if the very problem to which Wolf alluded in the quote at the outset above. That is, Wolf says that a boost to the economy is not “sustainable” if it involves much more borrowing or a much lower interest rates than we’re used to. Likewise it could be argued that issuing larger amounts of base money than has hithertoo been the norm, is not “sustainable”.

Well the answer to that is that just because something is unusual by historical standards, that does not mean it is unsustainable. It could be the new norm. To illustrate, if the citizens of some European or North American country took to accumulating large stocks of saving like Japanese households do (in the form of base money and/or government debt) then the government of that country would just have to accommodate that desire to save by running a relatively large deficit for several years, and thus letting private sector savings build up.

Doing that, while it does have obvious risks, is better than making no attempt to boost demand and thus having an excessive proportion of the workforce condemned to unemployment.

Tuesday, 14 April 2015

Frances Coppola correctly identifies a weakness in the proposal to ban private money creation or "printing" in the tweets below. Incidentally the Icelandic proposals are a straight copy of Positive Money proposals far as I can see.I reproduced those tweets via screen shots which is a quick though not the best way of doing it. If you find them too blurred, clicking on them may help. The weakness Frances points to is that the investment account department or subsidiary of a bank can still suffer a run or go bust. One answer to that is simply to raise the capital ratio of the department / subsidiary to whatever level makes failure near impossible. I suspect Pos Money's answer is the same, though I don't speak for them.However I don't like that solution. I'd prefer to simply raise the capital ratio to 100%, which amounts to funding those investment account departments just with equity: i.e. there'd be nothing that faintly resembles a deposit or "money". And indeed the latter is what happens under the version of full reserve advocated by Milton Friedman and Laurence Kotlikoff. Reasons are as follows.Under full reserve banking, people and firms can keep whatever amount of money they like in a totally safe form in the safe accounts: that's basically the amount of money that households and firms need for day to day transactions. Though if a household or firm really wants to keep far more than that amount of money in a totally safe form, they're free to do so.Having done that, what then is the point in offering something that's getting a bit close to money in transaction accounts? That's duplication of effort. Note: the material below is NOT A COMPLETE reproduction of our twitter conversation, but it will give you a flavor.

The Fed thinks that bond funds are potentially unstable: investors might want to withdraw from them quicker than the bonds or underlying assets can be sold, other than at fire-sale prices.

Well the solution is to treat bonds the same as money market mutual funds which are being forced to obey the rules of full reserve banking. That is MMMFs which simply lodge investors’ money at the central bank and/or in short term government debt will be allowed to promise to return $X to investors for every $X invested. In contrast, MMMFs which invest in anything else, e.g. corporate bonds, will have to let the value of investors’ stakes in the relevant MMMF float in value.Given a mass exodus from GM shares, the share price would crash. Everyone knows that, and no one is bothered. If the value of stakes in bond funds crashed given too fast an exodus, then I suggest no one would be bothered. In fact I thought that was already the case with bond funds. But if I'm wrong there, then the solution is to let bond fund stakes float just like GM shares.

Saturday, 11 April 2015

Jamie Dimon says on p.33 of his latest letter to J.P.Morgan shareholders: “In a crisis, everyone rushes into Treasuries to protect themselves. In the last crisis, many investors sold risky assets and added more than $2 trillion to their ownership of Treasuries (by buying Treasuries or government money market funds). This will be even more true in the next crisis.”

First, it’s good to know there’s definitely another crisis coming. Just to confirm that, on p.30 Dimon says “Most important, we will enter the next crisis with a banking system that is stronger than it has ever been.” And on p.31 he says “I will write about this later in this section when we go through a thought exercise of the next crisis.” And on p.32 there’s a heading which runs “Some things never change — there will be another crisis, and its impact will be felt by the financial markets.”

So we can all sleep soundly, ho ho.

Second, how is it possible for “everyone” in the aggregate to “rush into Treasuries”? Or to be more accurate, how is it possible for everyone to rush into one of the safest of all assets, namely US government liabilities? By “government liabilities” I mean government debt (e.g. Treasuries) and base money.

The total stock of those two (government debt and base money) is pretty much fixed in the short term. Of course that total stock can be altered by government deficits or surpluses, but given the typical size of deficits and surpluses, the above “total stock” just can’t change much over the period of a month or two – the sort of period over which we can switch from all “calm and collected” mode into full blown crisis mode.

So in a crisis, if one person moves $X into Treasuries (or more generally into “government liabilities”), it’s a near certainty that someone else moves $X out.

Thursday, 9 April 2015

Jamie Dimon is complaining, according to this Bloomberg article, about the shortgage of Treasuries. Well boo hoo. Why exactly is there an obligation on the citizens of a country to run into debt so that Wall Street scum can have the amount of interest yielding safe assets they want?

I also like the claim by Dimon that “It’s just a matter of time until some political, economic or market event triggers another financial crisis…”. Translated into plain English that’s: “Bankster / criminals have been successful in bribing politicians into not implementing regulations that would render the bank system more stable, and that suits banksters because it means they can run larger risks than they otherwise would and keep the profits, and when the risks DON’T PAY OFF, the taxpayer comes riding to the rescue.”

Wednesday, 8 April 2015

Positve Money, the New Economics Foundation and Richard Werner criticised interest rate adjustments in their submission to the Vickers commission a few years ago.

It’s good to see two other powerful voices criticising monetary policy recently. The first is Bernanke. And the second is Bill Mitchell.

A further weakness in interest rate adjustments is that they are DISTORTIONARY. That is (assuming the work at all) they only adjust lending / investment activity, and not non-lending / current consumption activity. That’s a bit like doing a helicopter drop on households inhabited by blondes and redheads, while people with brown and black hair wait for a trickle down effect.

Monday, 6 April 2015

One of the basic activities of banks under the existing system is to (1) accept money from depositors and bond holders, (2) invest or lend on that money, and (3) promise to return to depositors and bond holders the exact sum borrowed from them.

That promise is basically FRAUDULENT, and for the simple reason that loans and investments go wrong from time to time. I.e. the above promise is no different to borrowing money off a friend, second, promising to return the money, while third, putting the money on a horse. In contrast, if you tell your friend what your’re doing and agree to share profits and losses, then that’s honest. That’s non-fraudulent. And in that case, your friend has effectively bought a share in your horse betting business.

It could be said against the above point that if the proportion of a bank’s funding that comes from shares (its “capital ratio”) is much higher than currently obtains (e.g. if the ratio was raised to the 30% or so advocated by Martin Wolf and Anat Admati) then the chances of the bank going bust are remote, thus there’d be no harm in letting banks be funded partially by bonds.

Well the first answer to that is that there have been cases of small banks going bust in the US where it has turned out that the bank’s assets have dropped by much more than 30% as compared to book value.

Second, if funding via bonds was cheaper than funding via shares, that might be an argument for allowing bank bonds. However, funding via bonds just isn't cheaper.

Modigliani Miller.

Of course, many people THINK that funding via bonds is cheaper because the return demanded by bond holders is less than the return demanded by shareholders. But that difference simply reflects the fact that in the event of problems, shareholders take a hair-cut before bond holders.

The reality, as pointed out by Modigliani and Miller is that the cost of funding a bank or indeed any corporation is determined by the risks it runs – in the case of a bank, whether it specialises for example in NINJA mortgages or standard mortgages. And those risks are TOTALLY UNAFFECTED by the way the corporation is funded.

In short, having a bank funded 100% by shares rather than say 50% by shares and 50% by bonds will have NO EFFECT on the cost of funding.

Incidentally, the Modigliani Miller theory HAS BEEN criticised, but the criticisms are pretty feeble. See under the heading “Flawed criticisms of Modigliani Miller” (p.15) here.

What exactly is a bond?

A bond is a promise by a bank or any other corporation to repay sums borrowed from bond holders on some due date. And if the corporation CANNOT pay on the due date, the corporation undertakes to declare itself insolvent with bond holders getting less than 100 cents in the dollar after insolvency proceedings are complete.

But what exactly is achieved by that arrangement as compared to funding a corporation via shares? The answer is “exactly and precisely nothing because bond holders end up getting exactly the same as had they bought shares instead of bonds”. At least that’s true given a perfectly reasonable simplifying assumption, as follows.

Suppose a corporation is funded 50% by shares and 50% by bonds. And let’s assume the value of shares and bonds is strictly related to the value of the corporation’s assets. Of course in the real world, the value of shares and bonds is also influenced by the market’s view of the corporation’s prospects. But that’s what might be called a “wild card”: it can result in the value of shares and bonds being ABOVE OR BELOW a valuation based just on the value of the above assets.

So let’s ignore “prospects” and concentrate on assets.

If the value of the assets of the above “50:50” corporation falls to 50% of book value, then shareholders are wiped out, while bonds will still be worth their book value. And if the value of assets falls to say 25% of book value, then bond holders will get half their money back (50 cents in the dollar) after insolvency proceedings are complete.

But suppose instead that the corporation is funded 50% by ordinary shares and 50% by preference shares. And suppose, again, that asset values fall to 25% of book value. As above, ordinary shareholders are wiped out, while preference shareholders find that half their stake in the corporation has been wiped out: if you like, their stake is worth 50 cents in the dollar. And that’s exactly the same outcome as had those preference shareholders bought bonds instead.

The only difference is that in the bond scenario, the corporation is closed down, while in the preference share scenario, the corporation soldiers on, which is a slightly better outcome.

To summarise, what do bonds achieve? Absolutely nothing! They’re a farce!

A bond is essentially a promise by a firm to close down, i.e. to blow its brains out, if it cannot repay bondholders on the due date. And that is a fatuous promise.

However, I believe in free markets, and if some corporation really wants to blow its brains out should it not be able to repay bondholders, then I think on balance that it should be allowed to. However I wouldn’t strongly disagree with anyone who argued that promises to blow one’s brains out or burn one’s house down should be banned.

But whatever the truth of the latter point, banks are different to other corporations. As has been graphically illustrated over the last five years or so, the failure of large banks has serious systemic consequences: e.g. five years of excess unemployment. Thus I suggest bank bonds might as well be banned. That’s a nice simple rule, and there’s much to be said for simple rules, assuming all else is approximately equal.

Bail in bonds.

Another option is to allow bonds, but to bail them in when problems arise.

However, there are a few problems there. First, anything that gives preference to those with inside information is undesirable, e.g. it enables insiders to flee before others. Second, “bailinable” or “haircuttable” bonds come to the same thing as preference shares. Third, the idea that bank regulators actually know when a bank is in trouble is a joke, if past performance of regulators is any guide.

So why don’t we just cut the cr*p and ban bank bonds? Those wanting to fund banks would buy ordinary or preference shares instead, and the latter two come to the same thing as bonds. Plus that ban would mean that regulators (whose competence is in any case very questionable) needn’t get involved.

Saturday, 4 April 2015

First, the authors (unlike many who write on this subject) do have a reasonable grasp of what FR consists of: their first two or three pages explain what FR is as they see it.

However, they start going off the rails on p.4 which contains the following bizarre sentence: “Even if it were feasible for the state to establish control of the money supply, there would be little scope for credit intermediation or maturity transformation.”

Now as the authors themselves rightly point out, under FR, the bank industry is split in two. One half is totally safe – it does nothing the least risky with depositor’s money, and certainly does not lend money to mortgagors or businesses. The second half which is funded or largely funded by shares DOES LEND to businesses etc. And that activity equals “credit intermediation” at least as I understand the latter phrase. (The Sheffield authors do not define the phrase, so I can only make an educated guess as to what is meant by the phrase)

That is, credit intermediation involves connecting borrowers with lenders. So what’s all that about “little scope for credit intermediation”?

Different versions of FR.

There are of course different versions of FR apart from the Positive Money / New Economics Foundation (PM/NEF) version which is what the Sheffield paper concentrates on. E.g. there is Laurence Kotlikoff’s and Milton Friedman’s version. (And since the authors do not mention Friedman, I assume they are unaware that he backed full reserve.)

Under PM/NEF (and contrary to the Sheffield authors’ suggestions) maturity transformation CERTAINLY takes place in that relatively short term deposits (of a few months) fund much longer term loans. In contrast, under Kotlikoff and Friedman’s versions, it’s essentially shareholders who fund loans, and in that scenario, the phrase “maturity transformation” takes on a different meaning.

However, shareholders are “lenders” of a sort, thus contrary to the Sheffield author’s suggestions, even under Kotlikoff and Friedman’s versions of FR, lenders are connected to borrowers, i.e. intermediation takes place.

The main critique of FR.

The author’s main criticism of FR comes in their section 3.1 headed “Full Reserve Banking: A Critique” (p.8). And this section gets off to a bad start: the first sentence reads, “Embedded in all the full reserve banking proposals is the idea that it is socially unacceptable to have a money supply which is almost entirely determined by the private sector.”

Yes - if you needed to read that sentence twice then don’t worry: so did I. The sentence is plain bizarre.

The reality is that (as PM/NEF explain) under PM/NEF, money is kept in safe accounts: indeed PM/NEF go to considerable lengths to try to ensure that those buying a stake in the riskier half of the bank industry DO NOT treat their stakes as money.

So the Sheffield authors claim that advocates of FR think it’s unacceptable for the total amount in safe accounts to be “determined by the private sector”. Well the trouble with that claim is that it flatly contradicts the point very specifically made by PM/NEF namely that given the Keynsian paradox of thrift unemployment (i.e. an increased desire for money savings), the state should MEET THAT DESIRE for more savings: i.e. create and spend extra base money into the private sector. (Indeed, advocates of Modern Monetary Theory advocate exactly the same thing when they talk about the need to meet the private sector’s “savings desires” (to use MMT parlance)).
(But see P.S. below for more on the latter points.)

Safe assets.

The rest of the first paragraph of section 3.1 points out that trust in commercial banks is degraded or destroyed by crises like the one that occurred in 2007/8. But the authors have a great solution for the latter problem. As they put it, “In fact, because of state backing of deposit insurance, public trust in bank deposits as a store of value has been maintained in spite of the crisis.”

Well of course! But that “state backing” is a subsidy of the private banking system! And it is widely accepted in economics that subsidies misallocate resources (unless there are overwhelming social reasons for a subsidy as is the case with for example children’s education). The Sheffield department of economics perhaps needs to be reminded that economics is all about the allocation of resources.

To be more accurate, deposit insurance in the UK is funded by taxpayers, whereas deposit insurance in the US in the case of small banks is self-funding: banks pay a premium to the Federal Deposit Insurance Corporation. As to larger banks, it’s essentially taxpayers that have to foot the bill: witness the billions if not trillions of public money used to prop up those large banks during the recent crisis. And the reason for that is that there’s only one entity that can rescue large banks, namely the state itself. And even some states (e.g. Ireland) were near bankrupted by their attempts to rescue their banks.

Settling up.

The second paragraph of this section criticises FR on the grounds that “the availability of safe assets would be reduced…”. That’s a reference to the fact that taxpayers no longer underwrite loans or investments which involve more risk that that involved in government debt.

As readers will probably notice, that’s essentially a repetition of the point made in the FIRST paragraph of this section: that is, the Sheffield authors are asking for loans and investments to be backed by (i.e. subsidised by) taxpayers.

And if that’s what the Sheffield authors want, perhaps they can explain why they don’t advocate the entire stock exchange being made risk free gratis the taxpayer.

Stores of value.

Next, the Sheffield authors make this claim in respect of traditional bank deposits: “Bank deposits thus perform the money function of means of payment. In addition they act as a store of value, as long as there is public trust in bank deposits.” No: wrong again.

The mistake there is that for every pound of commercial bank issued money there is a pound of debt. And incidentally it’s not just advocates of FR who make that point: advocates of Modern Monetary Theory (MMT) have made the same point numerous times. For example as Bill Mitchell put it, “…horizontal money nets to nothing”. Thus reducing commercial bank deposits does not reduce the stock of “safe assets”: it has no effect on the NET stock of such assets AT ALL!!

In the same paragraph, the authors then claim that since people can no longer save at commercial banks, they’d be forced to place their savings in the riskier half of the FR system: a half where, as the authors rightly point out, savers are required to make judgements about the risks involved in different types of saving or investment. And that, according to the authors, would be a disaster: they claim, “It is totally unreasonable to expect the general public to undertake this kind of assessment and bear the consequences of a financial failure without deposit insurance.”

Now there are three errors there.

First, as already pointed out, the existing commercial banking system does not offer the public a way of saving, or more accurately a way of “net saving” in that for every pound of saving, there is a pound of debt.

Second, since FR involves REPLACING commercial bank money with base money or “sovereign money”, FR would actually INCREASE the scope for risk free saving, since base money is a form of risk free saving from the public’s perspective.

Third, the claim that it would be a disaster if members of the public have to make choices about the riskiness of various types of saving flies in the face of the fact that members of the public ALREADY make choices of that sort. The decision of save in the form of buying a house involves risk: e.g. the value of the house can rise or fall. The decision to save in the form of buying a house with a view to letting it involves risk: the tenants might not pay the rent and the landlord may have to spend hundreds or thousands in legal fees having the tenants evicted. Members of the public buy into unit trusts (mutual funds in the US) all of which have varying levels of risk.

About the only faintly valid idea in the latter passage by the Sheffield authors is the idea that members of the public should have a very safe method of saving available to them for those who want that. Well FR provides just that. First (as mentioned above) there is the safe half of the bank industry that exists under FR. Second, and as regards the riskier half of the industry, people under most versions of FR have a CHOICE as to what to put their savings into. If they want something that resembles a traditional British building society, that sort of thing certainly ought to be made available.

Zero interest on safe accounts?

And the final sentence of that paragraph by the Sheffield authors reads, “Yet the only alternative on offer is zero - risk deposits earning zero return and in fact, if banks are to be induced to manage them, probably attracting bank fees.”

Er, no. As suggested by Milton Friedman in his book “A Program for Monetary Stability” (Ch.3), the safe half of the industry could be allowed to invest in short term government debt, which would earn some interest.

But even if no interest was earned and depositors had to pay “bank fees” what of it? That’s already the case! To illustrate, I personally pay about £12/month in fees for my current / checking account at a well-known British high street bank and get no interest.

And finally, it could be argued that under FR, those with safe accounts would get no interest while paying even LARGER fees than currently obtain on British high street bank current accounts because money from the latter accounts IS loaned on, whereas under FR it possibly isn't. Well the answer to that is that there’s no such thing as a risk free set of loans or investments (think Spanish and Irish property loans if you want an example of loans that went DRAMATICALLY wrong). And if any set of bank deposits and corresponding loans APPEARS TO BE RISK FREE, then you’ve been hoodwinked. That is, given that risk exists, someone somewhere must carry the risk, and under the existing system, to a significant extent it’s the taxpayer.

As the Independent Commission on Banking put it “The risks inevitably associated with banking have to sit somewhere, and it should not be with taxpayers.” In contrast, the Sheffield authors clearly want to load risk onto taxpayers. Or perhaps, like most of the population, the Sheffield authors think there are free lunches to be had: in particular that something inherently risky can be made risk-free and at no cost.

Shadow banks.

The next paragraph of the Sheffield paper makes a claim against FR which I’ve seen dozens of times before. To quote, the authors say “It is therefore conceivable that 100% reserve requirements on depository institutions would ‘just drive even more finance into shadow banking, and make the system even riskier’”. Incidentally the “just drive…” quote is from Krugman.

Well it’s pretty obvious that if something is banned in any industry, that a number of informal or back-street members of that industry will try to circumvent the regulations. In fact it makes no different what bank regulations we have, about the only certainty is that banks (large and small) will try to circumvent the regulations.

The first and obvious answer to that criticism is that if we’re going to regulate banks, we should regulate ALL BANKS. To regulate just the major banks (which is what happened prior to the crisis) is absurd. Or in the words of Adair Turner (former head of the UK’s Financial Services Authority), “If to looks like a bank, and quacks like a bank, it should be subject the same bank-like safeguards”.

Moreover, even if it proves difficult to regulate the smaller shadow banks, that’s not too much of a problem and for the very simple reason that the only way of getting your liabilities WIDELY ACCEPTED as money is to be a large bank which is well know all over the country. Thus while there are various functions that small shadow banks no doubt perform very well, issuing a widely accepted form of money just isn’t one of them.

Limiting the supply of money.

The next paragraph of the Sheffield paper starts, “While the full reserve banking proposals envisage enforced (endogenous or exogenous) limitations on the supply of money, monetary history demonstrates that societies develop money assets according to need, making that enforcement very difficult.”

Now in exactly what sense does FR fail to supply the quantity of money that is “needed”? Much the most important sense in which the money supply should met “needs” is the “need” to supply enough money to keep the economy operating at full employment, i.e. the maximum level of employment that is compatible with acceptable inflation. And lo and behold that’s EXACTLY WHAT the authorities aim to do under FR: that is, they aim to create and spend into the economy every year the amount of money that achieves the latter objective (full employment).

In contrast, commercial banks fail utterly to provide the economy with the amount of money “needed” to bring full employment. That is, commercial banks act in a pro-cyclical manner: they print and lend out money like there’s no tomorrow in a boom and thus exacerbate the boom (just what we don’t “need” them to do). Then come a recession, commercial banks call in loans and their money creation activities grind to a halt.

Any idea that the commercial bank money creation system meets the “needs” of our economy is laughable.

A “no central bank” scenario.

Next, at the bottom of p.9, the authors make the point that absent a central bank, commercial banks are likely to set up in business and supply a country with some sort of money, the example they cite being the early years of Scottish banking.

Well it’s perfectly true that absent a central bank, one or more commercial banks are likely set up in business. But that’s irrelevant because the reality is that nowadays we have central banks, thus the crucial question nowadays is whether we have, 1, a commercial bank money only system, 2, a central bank money only system, or 3, a mixture of both.

The authors then make the point that while commercial banking worked well in Scotland for a while, “More recent experience of banking indicates the ever increasing scope for much more damaging endogenous financial developments..”. Yes quite. What happened in 2007/8 indicates that there is something seriously wrong with the commercial bank system.

Next, the authors say “Not only is the supply of credit relevant to the development process, but it is relevant too to the income multiplier process, whereby bank credit allows investment to precede the generation of the saving to finance it.” Whaat? It’s possible to invest BEFORE making the savings required to actually effect an investment? This is good news. Hopefully the authors will at some stage expand on this bit of good news, and while doing so, perhaps they can answer the following points.

Assuming an economy is at capacity (aka full employment) and an investment is going to be made, it just isn’t possible to lend the investor the relevant money and let the investment go ahead. What would happen is that demand would then become excessive, and the state would have to impose some sort of deflationary measure: e.g. an interest rate rise which would cut the amount of borrowing and investment back to where it originally was.

In short, if demand is to stay constant, saving (i.e. reducing expenditure on consumer goods and the like has to done AT THE SAME TIME as expanding expenditure on capital or investment goods).

Section 3.2: Controls on the supply of credit and money.

Most of the Sheffield paper (unlike much of the material produced by academics) is clear, if mistaken. Unfortunately the opening paragraphs of section 3.2, in contrast, are verbose gobblegook.

The first paragraph (assuming I’ve understood it correctly) simply makes the point that it’s difficult to predict exactly how well the Positive Money / New Economic Foundation (PM/NEF) version of full reserve would work in practice. Well: revelation of the century! When trying anything new, there are normally teething problems.

The second paragraph is in much the same vein: near meaningless waffle. However, it does contain one sentence I agree with: “The challenge for the committee to identify productive uses of credit is also not insignificant..”

That’s a reference to a peculiarity of PM/NEF, namely that under that version, the state tries to identify allegedly “productive” forms of investment and steer loans in that direction and away from allegedly “unproductive” forms of investment. I criticised that productive / unproductive distinction here.

Revelation: economists are not omniscient.

The next paragraph of the Sheffield paper (starting “Even if we accept…”) makes the profoundly stupid point that under PM/NEF, the committee tasked with determining how much stimulus the economy should get in the next six months or whatever might not estimate the amount of stimulus correctly. Well: you don’t say.

I have news for the Sheffield authors: about 99% of economists admit to not being omniscient. Moreover, those tasked with estimating the amount of stimulus that is suitable UNDER THE EXISTING SYSTEM (as they themselves are doubt less the first to admit) do not get their estimates right much of the time.

Repeat after me: FR does not equal monetarism.

Next on p.12 (para starting “To focus on the money supply…”), the Sheffield authors claim that FR, or at least the PM/NEF version of FR, relies just on the size of the money supply to give us stimulus. (Incidentally the same criticism was made by Ann Pettifor.)

Clearly the authors (and Ann Pettifor) don’t understand the difference between fiscal and monetary effects. As the authors correctly point out, PM/NEF involves imparting stimulus by having the state simply create fresh base money and spend it (and/or cut taxes). And that of course increases the stock of base money held by the private sector, which is a monetary effect. (Incidentally, it’s not just PM/NEF who advocate that idea: most advocates of Modern Monetary Theory advocate the same, far as I can see).

However, the fact of SPENDING that new money is a FISCAL effect. That is (and it’s amazing that I need to spell this out), when the state prints money and spends it on say education and health, one effect is to create jobs for teachers, doctors and nurses, EVEN IF there is monetary effect.

However, while it’s doubtless true that Milton Friedman placed too much emphasis on monetary effects, the opposite extreme, i.e. the idea that the stock of money that households have has NO EFFECT WHATEVER on their weekly spending is clearly nonsense as well.

Section 4. Iceland.

The rest of the Sheffield paper is concerned specifically with Icelandic banks since the crisis started. As the authors put it, “…in section four we look at the behaviour of Icelandic bankers responding to the full reserve requirement constraint in 2008…”.

Now if the rules of FR really had been imposed on Icelandic banks, then doubtless there would have been lessons. But it’s quite clear that so such rules WERE NOT IMPOSED. What did happen, as the authors explain, is that ONE HALF of the FR rules were imposed on the subsidiary of just one Icelandic bank (Kaupthing) operating in Britain. That half is the safe half of the industry and (to repeat) the basic rule is that deposits can only be lodged with the central bank and perhaps also invested in short term government debt.

I.e. the other half of the FR rules, namely the requirement that the half of a bank or of the banking industry which lends must be funded by shares and/or long term deposits was not imposed.

All in all, the idea that there are lessons there for FR is a bit of a joke.

And a second joke here is that we’ve actually had a bank in the UK for decades which obeys the rules of the above “first half”: National Savings and Investments. NSI (as per the above “first half rule”) invests just in base money and government debt. Granted NSI does not carry out all the functions of a normal bank, e.g. NSI does not issue cheque books or debit cards to its customers. However to all intents of purposes it does the same thing: it lets customers transfer sums out of NSI within 24 hours via phone.

And a third point or “joke” here is that a report has recently been commissioned by and written for the prime minister of Iceland which advocates adopting Positive Money policies more or less lock, stock and barrel. Presumably the author of that report wouldn’t be so dumb as to be unaware of the above “lessons” if indeed there were any to be learned.

Revelation: banks try to circumvent regulations.

At any rate, what’s the big lesson that we can apparently learn from the experience of the Kaupthing subsidiary according to the Sheffield authors? Well the only lesson seems to be that banks put a lot of effort into circumventing regulations (something the Kaupthing subsidiary managed to do), and that this can render regulations of the sort advocated by PM/NEF impotent.

Well the idea that banks spend a lot of time breaking the law is hardly news, given the $100bn of fines that banks have had to pay in the US (yes that’s billion, not million). Moreover, the efforts that banks put into circumventing regulations is a problem with ANY SET of regulations, not just the PM/NEF regulations!

However, the simpler regulations are, the more difficult they are to circumvent, all else equal. And the rules of FR as simplicity itself. To repeat, the basic rules are, 1, deposits which depositors want to be totally safe can only be lodged with the central bank or invested in short term government. 2, as regards loans by banks, those must be funded by equity or largely by equity or by a mixture of equity and long term deposits. Compare that to the 10,000 pages of Frank-Dodd!

Conclusion.

And the final error in the Sheffield paper is in the first sentence of the conclusion which reads, “Full reserve banking plans arose out of the perception that the crisis resulted from excessive bank credit, which was the counterpart to uncontrolled money creation.”

In fact Irving Fisher in the 1930s put a lot of effort into promoting full reserve. And for all I know the idea is even older than that. Since the Sheffield authors do not mention Fisher, I assume they don’t know about him. Looks like the Sheffield authors need to do a fair amount of reading and thinking before opining on full reserve banking again.

________

P.S. 5pm, 4th April 2015. Under the heading “The main critique of FR” above I said the Sheffield authors accused FR advocates of claiming it was wrong for the money supply to be “entirely determined by the private sector”. I should have added that the real flaw in having the money supply determined by the private sector is that private banks quite clearly to do not supply the economy with the money it needs, especially in a recession. That is, private banks act PRO-CYCLICALLY, not counter cyclically. I.e. far from boosting the money supply in a recession, if anything, they do the opposite.

In contrast, under PM/NEF, the money supply is determined jointly by the private and public sector: that is the public sector aims to supply the private sector with whatever amount of money is needed to maximise numbers employed without exacerbating inflation too much.

Wednesday, 1 April 2015

Doug Elliott describes himself as a “fellow in economic studies” at the Brookings Institution. In this Brookings article (published in March 2015) he argues that while SOME additional bank capital is needed, having banks hold MORE CAPITAL than required by Basel III Accord would be counterproductive.

The basic flaw in the idea that additional capital adds to the cost of funding banks (or indeed any corporation) was explained by two economics Nobel laureates, Franco Modigliani and Merton Miller. And the flaw is thus. Obviously shareholders take a bigger risk than debt holders (i.e. depositors and bond holders). But if the proportion of a bank’s funding that comes from shares is raised, that in no way affects the TOTAL RISK involved in running the bank. That total risk is after all determined just by the nature of the loans and investments made by the bank: they may be high risk (e.g. NINJA mortgages) or low risk. And if the total risk is unchanged, then the total cost of funding the bank remains unchanged when the bank’s capital ratio is raised. I.e. when bank capital is raised, the risk PER SHARE falls, thus the return demanded by shareholders PER SHARE will fall.

Thankfully Elliott at least understands the basics of the Modigliani Miller theory (MM). As he puts it:

“At first blush, it seems obvious that higher capital levels come with a cost, since shareholders demand higher returns than depositors or bond buyers, to compensate shareholders for taking the most risk. However, Modigliani and Miller, two Nobel-Prize winning economists, showed years ago that the increased safety that comes with more capital reduces the unit cost of all forms of funding in a way that exactly offsets the use of more of the expensive form – in idealized conditions. Some academics have built on this to argue strongly for much higher levels of required capital and gone so far as to claim that it is free from society’s point of view.”

The alleged tax flaw in MM.

However, Elliott claims there are flaws in MM, the biggest of which, apparently, is the fact that the tax treatment of equity and debt is different. (See the para of his just after the above quoted para).

Well there’s a phenomenally simple flaw in that tax point, which is that tax is an ENTIRELY ARTIFICIAL imposition: that is, the AFTER TAX price of any item is not a reflection of that item’s REAL COST. The only exception to that is where a tax is imposed SPECIFICALLY to take account of a cost like the costs of pollution. For example if the tax on fuel for vehicles accurately reflects the environmental costs of burning carbon based fuels, then the after tax cost of such fuel is an accurate measure of the TOTAL cost of that fuel.

To summarise, the “main” objection to MM raised by Doug Elliott is easily demolished.

Elliott’s second criticism of MM.

The above article of Elliott’s refers readers to another of his Brookings Institution articles where he sets out further alleged weaknesses in MM.

Under the heading “The second area of disagreement: government guarantees” Elliott puts the bizarre argument that governments provide explicit and implicit guarantees for debt, thus banks can fund themselves relatively cheaply with debt. Ergo (apparently) debt is an inherently cheaper method of funding banks than equity.

Did you die of laughter at that one? I nearly did.

But just in case you didn’t spot the flaw in that argument, it’s very similar to the above first tax point. That is, government subsidies for X, Y or Z do not reduce the REAL COST of X, Y or Z. When government subsidises something, the APPARENT COST declines, but the REAL COST remains unaltered: all that happens is that taxpayers carry some of the cost. (It’s amazing that I need to explain that elementary point).

Conclusion.

Given the above glaring mistakes in Doug Elliott’s ideas on bank capital, I’ve got better things to do than investigate them any further. Plus as Elliott himself says that the above “tax” point is his MAIN objection to Modigliani Miller, thus I conclude that Elliott needs to go back to the drawing board.

And while Elliott is back at the drawing board, hopefully he will contemplate the fact that the average capital ratio of stock exchange quoted corporations in the UK is 37% according to this Economist article. That’s way above the 5% or so which is typical for a bank. If capital is inherently expensive, one has to wonder what those non-bank corporations think they’re doing.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

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Nice picture.

For source, Google: TREASURY: LA LEGGENDA DEI BOND VIGILANTES!

Bits and bobs.

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I do like Stephanie Kelton’s MMT colouring book. Filling in the colours should be a compulsory for all those with mental ages below three - i.e. all those under three, and all politicians over the age of three -….:-)________

90% of Euro banknotes issued in Germany are never spent: they’re just hoarded!!!!________

Thinking aloud….free banking (advocated by George Selgin and others) comes to the same thing as full reserve banking, seems to me. Reason is that under free banking there is no deposit insurance, thus deposits at banks are essentially equity: so called “depositors” stand to lose their shirts just like shareholders. At the same time, under free banking, depositors who want total safety are presumably free to deposit money at state run savings banks like National Savings and Investments in the UK. And that is effectively full reserve banking: loans are funded via equity, while no risks whatever are taken with deposits that are supposed to be totally safe.________

This is a laugh. One of the biggest consumers of carbon based fuels in the world, the US Air Force, complains about climate change.________

Like many people, I'm getting increasingly tired of the censorship on Twitter. I've started moving to alternative sites like gab.ai and reddit. Obviously if the censorship gets much worse, I'll abandon Twitter altogether.________

Richard Murphy thinks he invented "Peoples' QE" (the idea that the state should print money and spend it in a recession). See last paragraph here.

Latest fashionable idea among the chattering classes is that central banks should promote environmentally friendly activities. So why not have CBs promote every other worthy cause, like education, health care, you name it? Reason is that having CBs stick their noses in sundry worthy causes is just duplication of effort. E.g. we can have any cut in CO2 emissions we want by simply imposing a sufficiently heavy tax on carbon based fuels, so why have a second lot of bureaucrats doing what an existing lot of bureaucrats can do at little extra administrative expense? Moreover, CBs are supposed to keep out of politics.

On the other hand it can well be argue that global warming is so serious that absolutely any method of cutting it is acceptable, however daft. Also there is some evidence that central banks' bond buying exercise has been skewed towards carbon based fuel producers etc. Certainly if CBs are to buy private sector bonds, the skew is not acceptable. However, buying private sector assets is silly way to impart stimulus. Reasons are in a long article coming up in a day or two. ________

According to this source, agricultural land in the UK changes hands for an average of £21,000 per hectare. Land with planning permission changes hands for £6million. Raving bonkers. I don't mind a finite markup when planning permission is granted, but that £6million is totally absurd. More land should be made available for building houses.

Actually I suspect that £6million figure is wrong: I've seen £1million and £2million cited quite often before, but not £6million. But even £1million is ridiculous.__________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A